The majority of Americans are facing a significant financial shortfall when it comes to retirement savings. Even when you factor in Social Security as an income source, the average American family's retirement savings don't come close to enough of a nest egg to support a comfortable lifestyle in retirement. Here's what the average American has saved, and why starting an IRA as soon as possible could save your retirement.

Americans aren't doing a great job of saving for retirement

If you read the financial news at all, it shouldn't come as a surprise that as a whole, Americans aren't doing a great job of saving for retirement.

40-something couple reading the financial news.

Image Source: Getty Images.

According to a report from the Economic Policy Institute (EPI), the average retirement savings of an American working-age (32-61 years old) family is $95,776. By age group, here are the averages:

Age Group

Average (mean) Retirement Savings











Data Source: Economic Policy Institute. Retirement savings include 401(k)s and similar plans, IRAs, and Keogh plans.

Here's the point. Experts suggest that retirees can safely withdraw 4% of their retirement savings per year, and increase the withdrawal rate in future years to keep up with inflation. This implies that the average 56-61 year old pre-retiree household's savings can only be expected to produce about $6,340 in sustainable income.

Worse yet, the median retirement savings of all working-age families is just $5,000. This means that half of all families have less than $5,000 in total retirement savings, indicating that the averages are skewed upward by a few super-savers, while most Americans have little or no retirement savings.

The amount of savings you should have depends on a few factors, such as your pre-retirement income, amount of Social Security and pensions you should expect, as well as your specific goals for retirement. Here's a quick guide that could help you determine your retirement "number."

Social Security isn't likely to be enough

To be clear, in all likelihood, Social Security will still be around after you retire. If you hear someone tell you that Social Security is going to go bankrupt and will disappear, you owe it to yourself to learn the truth about the financial condition of the program.

However, this doesn't mean that it's a good idea to rely on Social Security as your primary source of income. Generally speaking, the average retiree needs somewhere between 60% and 90% of their pre-retirement income to sustain the same quality of life.

Social Security is designed to replace about 40% of the average retiree's income, so it's fair to assume that you'll need to make some serious lifestyle sacrifices if you don't have any other savings, or even if you have just the average American's retirement savings.

What is an IRA?

An IRA, which stands for individual retirement account (or individual retirement arrangement), is a tax-advantaged account designed to help Americans save and invest for retirement.

As of 2017, the annual IRA contribution limit is $5,500, with a $1,000 catch-up contribution allowed for people age 50 or older. It's important to note that this limit is per person, not per account. In other words, if you have more than one IRA, your total contributions can't exceed the limit.

Contributions can be invested in virtually any stock, bond, mutual fund, or ETF you want. In exchange for the tax benefits, which I'll discuss in the next section, you typically need to leave your money in the account until you're at least 59 ½ years old, unless you qualify for an exception.

Two types of IRA

There are two main types of IRA that most Americans can choose from. A traditional IRA is a tax-deferred retirement account, which means that you may qualify for a tax deduction for your contributions (subject to income limits and your employment situation). The funds can then be invested, and are allowed to compound without annual capital gains or dividend taxes. You don't pay taxes on traditional IRA investments until you withdraw the money.

On the other hand, a Roth IRA is an after-tax retirement account. You won't get a tax break for Roth IRA contributions, but your qualified withdrawals will be completely tax-free. In other words, you'll pay tax on that portion of your income now, but not on any investment gains it generates.

Because of its after-tax structure, there are several other benefits of Roth IRAs. For example, since you've already paid tax on your contributions, you are free to withdraw them (but not any investment gains) at any time, and for any reason. This makes a Roth a smart choice for people who don't necessarily want their money tied up until retirement. Roth IRAs also have no minimum distribution requirement as you get older.

Roth IRAs are income-restricted, but there is a "backdoor" method that higher-income individuals can use to invest through a Roth.

You might be surprised how your IRA contributions could add up

Here's why I'm placing so much emphasis on making contributions to an IRA. Let's say that you're 35 and that you make $5,500 annual contributions to an IRA until you're 65 and ready to retire. This adds up to $165,000 in IRA contributions altogether, which at first, may not sound much different than the average retiree's nest egg.

However, if your contributions generate 7% average yearly returns, which is actually quite conservative based on the stock and bond markets' historical performance, your IRA could be worth more than $560,000, which could make a big difference in your quality of life after retirement.